No fear of being a lemon picker

Sebastian Evans cheerfully admits a client called him a lemon picker recently. He says it comes with the territory when a fund takes on risk when investors are risk-averse.

But he’s only been picking lemons for a year. Evans, 26, is at the helm of NAOS Asset Management, a small-cap hedge fund that has had incredible success under his watch.

Despite growing up in finance – his father, Warwick, was a head of Macquarie Equities – he never thought about it as a career.

“I always thought I might be a pilot or a marine biologist, but got shunted into equities," he says.

Evans did a fast-track commerce degree at Bond University, followed by an internship with RBS Morgans and at age 20, Southern Cross Equities came knocking. It owned the majority of NAOS at the time and wanted him on board as an analyst.

Six months into his tenure, the global financial crisis struck. The portfolio manager and other senior managers left, leaving only a handful of analysts. Bell Potter took over Southern Cross and NAOS’s future was uncertain.

At 22, Evans stepped up as NAOS’s fund manager and started overhauling the fund. He made it more concentrated, covering only 20 companies, and took a punt on some relatively obscure micro-cap stocks.

His youth was both his greatest strength and weakness, Evans says in reflection. The reason why companies get rid of older people at the bottom of the market, he says, is because those people have such an aversion to risk after being decimated.

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“Young people, for good or for bad, are more willing to put their money where their mouth is . . . and that’s what they wanted us to do at NAOS," he explains.

He steered the fund away from resources and financial stocks, unlike many other small-cap funds.

“We decided to change the fund a bit by investing in companies that others didn’t, that were owned by no one," he says. “In hindsight it worked well, but a lot of people still don’t agree on how we invested. That’s fine but I still think there’s a market for it."

While this past year has been “rubbish", Evans admits, he readily points out that NAOS has consistently been one of the top five performers over the past three-year, five-year and seven-year periods. The fund has delivered positive returns every year, while its benchmark, the ASX Small Ordinaries index, has been negative most years. But recent performance has been poor, with NAOS down 32 per cent over the past year.

NAOS is set to get access to a wrap platform, which will make the fund more accessible to retail investors, and hopefully provide a boost to funds under management, which are languishing at $25 million.

The problem is, he says, investors are too short-sighted and fund managers’ memories are too long in the current environment. People have been burnt and consequently are looking to park money in safe, high-yielding stocks with good cash flow.

He points to marketing services group
Enero
that imploded during the GFC because it had too much debt. “Now it’s completely debt free and has acquired some of the best businesses around . . . but so many funds got burnt the first time, they don’t want to touch it."

Around half of the stocks in the portfolio don’t have cash flow, a problem when the market is hungry for it.

One example of this is
Reva Medical
, which is developing dissolvable plastic heart stems in a $6 billion market of only five other players. Besides Reva, only one has been able to develop the plastic stem. “The issue was, trials were delayed by six months. A lot of people looked at that and saw no cash flow for five years," he says.

But he is determined to prove he’s no one-hit wonder, and stands by diversifying portfolios. It’s always a case of down by the elevator and up by the stairs, he says.

“But even when we’re down 30 per cent in one year, if we can hack that and still be top five, that’s not so bad. It’s the nature of what we invest in, and it’s not for everyone."